Foreign selling bodes well for equities

20 Nov 2015

SHARE

Foreign selling bodes well for equities

Luke Kawa

The frenzied The flurry of repatriation that took place during the third quarter amid China's shock devaluation and the plunge in global equities bodes well for stocks, according to a somewhat counter-intuitive note out from Barclays this Thursday.

"With the recent publication of balance of payments data it is now clear that the 12 percent peak-to-trough drop in global equities was accompanied by some aggressive selling pressure from international investors," wrote Ian Scott, head of equity strategy. "During September alone non-residents sold $28 billion of U.S. equities, $25 billion of Japanese equities, $13 billion in emerging markets and although the euro area data have yet to be released, we know non-residents sold a net $2 billion of German stocks in the month."

The strategist notes that the only withdrawals on record that were notably more severe than this occasion occurred during the 1987 crash and the 2008 housing bust.

While dramatic plunges of this sort might give investors reason to fear, Scott has some (relatively) good news.

Net non-resident purchases of U.S., Japanese, and European equities, as well as emerging market mutual funds and exchange- traded funds, tend to be inversely correlated with future 12- month returns, Barclays found:

"Past behavior suggests that periods of heavy selling by non-resident investors tend to be followed by above average returns, while periods of especially strong buying by non- residents tend to be followed by below average returns," Scott concluded.

Moreover, valuations are not a major impediment to future stock price appreciation, according to Barclays.
Scott notes that the MSCI World Real return index is actually running marginally below its long-run trend. The market is by no means substantially undervalued, the strategist cautioned, which entails that future returns will be dictated by earnings growth.

"Global growth of 3.4 percent next year, and an expected removal of the oil price drag, should mean earnings growth recovers to 7 percent in 2016," he wrote.

Concerns about valuations have become more pressing with a potential rate hike from the Federal Reserve looming around the corner. Liftoff would presumably raise the risk-free rate of return and could in turn dampen the attractiveness of riskier assets like equities.

But the strategist says that stocks are relatively cheap given this backdrop.

"We would also point to the fact that global equity valuations are lower now than they were at the last three major turning points for U.S. rates," Scott observed. "This conclusion holds whether one refers to dividend yield, price-to-earnings, price-to-book, or cyclically-adjusted price-to-earnings [ratios]."

Six months after the first hike, the MSCI World Index advanced during these three previous occasions highlighted by Barclays, with an average gain of 15 percent.

By Scott's analysis, flows, fundamentals, and the Fed are all supportive of strength in global equities as the calendar flips over to 2016. Many investors will be hoping he's right.